08 May The 2 Sides to Oil Prices and Constructing a Portfolio around Oil
This is a guest post by Calvin Yeo from DrWealth.com
As a follow up to the article on finding gems during an oil crisis, Nam Cheong and Bumitama Agri, I decided to do some research on what goes up during an oil crisis. Just thinking of it intuitively, any companies which use oil intensively will benefit. Companies that come to mind are airlines like Singapore Airlines and transport companies like ComfortDelGro.
Understanding Negative Correlation
Based on the theory of oil prices, we can think of transport companies and oil companies as having negative correlation. It can definitely be seen during this year as ComfortDelGro (CDG) shot up, while SembCorp Marine (SBM) went down significantly.
Looking at the 5 year comparison chart, we can see CDG going down during 2011, while SBM went up. The negative correlation became extremely pronounced from 2013 onwards. You can see CDG climbing dramatically while SBM fell drastically.
Buy and Holding Stocks
Both CDG and SBM are considered strong blue chip stocks with decent dividend yields. Therefore they are both good candidates for buy and hold. So how would you perform if you bought and held them for 8 years?
Assuming you bought the stocks during the 2007 peak and held it through the great financial crisis in 2008, how would you have done?
The first portfolio assumes that you bought $100,000 of CDG at 2007 while second portfolio assumes that you bought $100,000 of SBM during the same time. As you can see, CDG has gone up a lot more than SBM by 2015, but underperforming from 2008 to 2012. SBM, on the other hand bounced back to positive by 2010.
Next, we try a 50/50 portfolio, where you buy $50,000 of CDG and $50,000 of SBM. The result is a value in between of 100% CDG and 100% SBM.
Rebalancing For More Returns
In the 4th portfolio, we rebalance yearly. When the prices shift, the values of CDG and SBM will shift from 50% each to say 60% and 40%. By rebalancing, we will buy the stock that went up and buy the stock that went down to bring it back to 50% each.
By rebalancing, we take advantage of market timing. As you can see, the values of the rebalancing perform much better than the 50/50 portfolio.
While the performance of the rebalancing portfolio is slightly less than 100% CDG portfolio, the CDG portfolio was more volatile and underwater from the period of 2008 to 2012. The returns of the rebalancing portfolio are also more consistent, producing returns of between 5.0% to 6.0%+ every year.
Value of Rebalancing
As you can see from this simple example, rebalancing is very useful tool that can be used not only to enhance returns of a portfolio but also to reduce volatility of the portfolio. With only 2 stocks on opposing sides of the oil prices, we are able to create a stable portfolio with consistent returns. Rebalancing is best used when constructing portfolios around ETFs, Rebalancing can be applied further to industries, global economies and so on.
About the Author
Calvin Yeo, CFA, CFP is the Managing Director of DrWealth, ASEAN’s leading site on personal finance. DrWealth offer users high quality articles and research on all areas of Personal Finance including Investments, Net Worth Tracking, Retirement Planning and more. Calvin is a widely sought after speaker and thought leader who has been featured on various media such as Business Times, Straits Times, 93.8 FM, Channel News Asia and more. Calvin is an avid investor in stocks, properties and bonds with more than 10 years experience.